ICDS – Will it make an Impact?

Mar 16, 2015

ByRajat Juneja

Formulation of Income Computation
and Disclosure Standards (‘ICDS’)

The Central
Government is empowered[see end note 1] to
notify ‘accounting standards’ under Section 145 of the Act[see end note 2] which
need to be necessarily followed while computing income under the head ‘profits
and gains of business or profession’ or ‘other sources’. In the year 1996[see end note 3],
two[see end note 4]
‘accounting standards’ were notified with the intention of ensuring that the
income is computed precisely and objectively.

For formulating
‘accounting standards’ to be notified under the Act, a committee was also
constituted later in July 2002, which recommended that the ‘accounting
standards’ issued by ICAI[see end note 5] should
be adopted with relevant modifications in the Act, wherever necessary. The
committee was of the view that it would be impractical for a taxpayer to
maintain two sets of books of accounts, i.e., one in accordance with the
standards issued by ICAI while the other in accordance with the standards
notified in the Act. The recommendations of the committee could not be implemented,
since it would have required extensive amendments to the Act which could have
rather resulted in complexities besides litigation.

Significant
developments took place thereafter firstly, by way of MCA notifying certain
‘accounting standards’ in the Companies Act, then subsequently, introduction of
Indian accounting standards (‘Ind-AS’) for facilitating convergence of Indian
accounting standards with IFRS by MCA and lastly and more importantly, in
absence of relevant accounting standards in the Act itself, uncertainty moved
around some issues which led to continued litigation.

Wary of these
difficulties, CBDT constituted another Committee in December 2010 to harmonise
the accounting standards issued by the ICAI with the provisions of the Act and
also for suggesting amendments to the Act required for transitioning to Indian
accounting standards. The committee examined all the 31 accounting standards in
force at that point of time and released 14 Tax accounting standards (‘TAS’)
for public comments (the rest 17 were pertaining to disclosure requirements and
therefore irrelevant from tax aspect) in October 2012. After examining the
suggestions of stake holders the CBDT released the revised drafts of 12 Income
Computation and Disclosure Standards (‘ICDS’) and invited suggestions of
various stakeholders and the general public.

The names of
all standards are changed from ‘TAS’ to ‘ICDS’, pursuant to amendment[see end note 6], to
clarify that the ‘ICDS’ apply only to computation of taxable income and tax
payers are not required to maintain separate books of account to comply with
‘ICDS’. Transitional provisions have also been inserted in all ‘ICDS’, which broadly
requires recognition of the concerned contract/transaction, asset, income,
expense, loss or provision existing as on or entered into on or after 1st
of April, 2015.

Controversy

Primarily, the
intention of introducing the ‘ICDS’ is to maintain uniformity and to remove
uncertainty besides reducing litigation as it attempts to purge alternative
accounting/tax treatments and it is certainly a welcome move! However, to what
extent it aims to settle some unsettled disputes and unsettle some settled
disputes is yet to be seen.

In this
Article, the author has examined one of such issues which have been a subject
matter of controversy of late, that ‘whether in respect of a Finance lease transaction,
the depreciation will be allowable in the hands of the ‘lessor’ or in the hands
of the ‘lessee’?

The distinction
between a ‘Finance lease’ and an ‘Operating lease’ is set out in Accounting
Standard (‘AS-19’) on Leases[see end note 7]
(as also in new set of ‘ICDS’). It further provides that in a Finance lease
transaction, typically, all the risks and rewards incidental to ownership vests
with the ‘lessee’ and it is the ‘lessee’ who is a actual and real owner and the ‘lessor’ is rather a nominal or symbolic owner and therefore
the depreciation in such cases is available in the hands of the ‘lessee’.Tribunal (SB) decision in the case of IndusInd
Bank Ltd.[see end note 8]
also held that depreciation is allowable in the hands of lessee in case of a
finance lease.

The relevance
of Accounting Standards was highlighted by the Supreme Court in CIT
v. Woodward Governor[see end note 9]
wherein it was held that the Accounting Standards which are continuously
adopted by an assessee, can be superseded or modified by legislative
intervention. However, but for such intervention, the method of accounting
undertaken by the assessee continuously is supreme.

Therefore in
absence of any contrary treatment prescribed in the Act, in a Finance lease
transaction, the treatment prescribed in ‘AS-19’ could thus have been followed
and the depreciation would be available in the hands of the ‘lessee’. However,
the controversy was ignited when the decision of the Supreme Court in I.C.D.S
Ltd. v. CIT [see end note 10] was
pronounced, wherein it was held the
‘lessor’ is entitled to claim the depreciation since in a finance lease
transaction it is the ‘lessor’ who is the legal owner of the asset and the use
by the ‘lessor’ in its leasing business would satisfy the test of use as well
and physical use of the asset is not necessary.

Let us examine
various provisions of the Act, to understand whether the law laid down by the
decision in I.C.D.S Ltd. (supra)
and its interplay with the ICDS (issued by CBDT)?

Legal position

As per the
mandate of section 32 of the Act, depreciation is available to the assessee who
‘owns’
the asset and ‘uses’ the same for the purposes of
its business. Therefore, the twin requirement of ‘ownership’ as well as ‘use’
is required to be met.

‘Ownership’ - does not necessarily co-exist with legal title. The
Supreme Court in the case of CIT v.
Podar Cement[see end note 11] settled the controversy on the
significance of ‘legal title’ in the context of Section 22 of the Act and held
that ‘owner is the person who is entitled to receive income from property in
his own right and not necessarily the person having legal title over that
property’.

Further, the
Supreme Court in Jodhamal Kuthiala v.
CIT[see end note 12]
also laid down certain propositions, (a) a property cannot be owned by two
persons, each one having independent and exclusive right over it; (b) the
concept has also to be looked into from practical point of view having regard
to reasonability and justice; (c) the meaning given to the word ‘owner’ must
not be such as to make the provision capable of being made an instrument of
oppression; (d) the word ‘owner’ has different meanings in different
contexts; (e) under certain
circumstances a lessee may be considered as the owner of the property leased to
him.

It was thus
held in the above case that ‘an assessee whose house property is vested in the
hands of a custodian, cannot be assessed as owner since the word ‘owner’ must
mean, a person who can exercise the rights of the owner and is entitled to the
income from the property’.

The Supreme
court, again, in the case of Mysore
Minerals v. CIT[see end note 13]
applying the above decisions, observed in the context of Section 32 of the Act,
that the term ‘owned’ must be assigned a wider meaning and anyone in possession
of property in his own title exercising dominion over the property as would
enable others being excluded there from and having the right to use and occupy
the property or to enjoy its usufruct in his own right would be the owner of
the building though a formal deed to title may not have been executed and
registered.

It therefore
emerges from the above decisions that, (a) legal title over the asset is not
decisive to determine the owner of the said asset; (b) depreciation under
Section 32 of the Act is a periodic allowance of the capital cost incurred and
hence should be available to the person incurring that cost in real sense
having regard to reasonableness and justice; (c) the lessee could also be
treated as the owner of the asset provided the lessee exercises such rights
over the asset which gives him the dominion over the asset and enable him to
enjoy the benefits there from.

‘Use’ - the assets should be used by the lessee for the
purposes of business which is being carried on and thus this test could be
satisfied in a relatively easier way.

CBDT Circular[see end note 14] states that the accounting treatment will have no
bearing on the allowance of depreciation on assets under the Act and ownership
of the asset needs to be determined having regard to the substance of the terms
between the ‘lessor’ and the ‘lessee’. Therefore, it does leave scope for a
case where based on terms, the ‘lessee’ would be treated to be owner for the
purpose of depreciation.

Conclusion

In a finance
lease transaction, where the terms of
the lease are such that the substantive rights incidental to ownership vests
with the ‘lessee’ while the ‘lessor’ continues to be the symbolic or nominal
owner, the depreciation could be claimed by the ‘lessee’. Therefore, where the substantive rights vests
with the ‘lessee’ and a sliced down legal tile with the ‘lessor’, it is the
‘lessee’ who should be considered to be the owner of the asset for the purpose
of Section 32 of the Act.

The Supreme
Court’s decision in I.C.D.S (supra) may be considered supreme for the set of facts.
Yet the ICDS issued by CBDT and Tribunal (SB) decision in the case of IndusInd
Bank Ltd.[see end note 15]
can still be validly applied in certain cases.

Undoubtedly,
the new set of ICDS seeks to put an end to the protracted litigation and bring
uniformity amidst the varied treatments prescribed in ICAI -AS and the MCA
notified Ind-AS, yet to some extent it settles some unsettled disputes and
unsettles some settled disputes.